August 8, 2017

In This Edition
Should You Convert From a C Corporation to an S Corporation?
Which Companies Can Elect S Status?
Exercising Corporate Due Diligence
Cool Down With a Dip Into Your Tax Records

Should You Convert From a C Corporation to an S Corporation?
Many private business owners elect to incorporate, turning their companies into C corporations. But, at some point, you may consider converting to an S corporation. This isn't necessarily a bad idea, but it's important to know the ramifications involved.

Similarities and Differences
S and C corporations use many of the same recordkeeping practices. Both types of entities maintain books, records and bank accounts separate from those of their owners. They also follow state rules regarding annual directors meetings, fees and administrative filings. And both must pay and withhold payroll taxes for working owners who are active in the business.

There are, however, a few important distinctions. First, S corporations don't incur corporate-level tax, so they don't report federal (and possibly state) income tax expenses on their income statements. Also, S corporations generally don't report prepaid income taxes, income taxes payable, or deferred income tax assets and liabilities on their balance sheets.

As an S corporation owner, you'd pay tax at the personal level on your share of the corporation's income and gains. The combined personal tax obligations of S corporation owners can be significant at higher income levels.

Dividends vs. Distributions
Other financial reporting differences between a C corporation and S corporation are   more subtle. For instance, when C corporations pay dividends, they're taxed twice. They pay tax at the corporate level when the company files its annual tax return, and the individual owners pay again when dividends and liquidation proceeds are taxed at the personal level.  

When S corporations pay distributions - the name for dividends paid by S corporations - the payout generally isn't subject to personal-level tax as long as the shares have positive tax "basis." (S corporation basis is typically a function of capital contributions, earnings and distributions.)

Risk of Tax Audits 
C corporations may be tempted to pay owners deductible above-market salaries to get cash out of the business and avoid the double taxation that comes with dividends. Conversely, S corporation owners may try to maximize tax-free distributions and pay owners below-market salaries to minimize payroll taxes.

The IRS is on the lookout for both scenarios. Corporations that compensate owners too much or too little may find themselves under audit. Regardless of entity type, an owner's compensation should always be commensurate with his or her skills, experience and business involvement.

The Right Decision
For businesses that qualify (see below), an S corporation conversion may be a wise move. But, as noted, there are rules and risks to consider. Also, as of this writing, there are tax reform proposals under consideration in Washington that could affect the impact of a conversion. Our firm can help you make the right decision.
Contact: Jeff Dvorachek, CPA
Which Companies Can Elect S Status?
Not every private business is eligible to be an S corporation. In order to elect S status, a company must:
  • Be a domestic corporation,
  • Have only allowable shareholders (individuals, certain trusts and estates, but not partnerships, corporations or nonresident alien shareholders),
  • Have no more than 100 shareholders,
  • Have only one class of stock, and
  • Not be an ineligible corporation, including certain financial institutions, insurance companies, and domestic international sales corporations.
All shareholders must consent to the S election by signing Form 2553, "Election by a Small Business Corporation."
Exercising Corporate Due Diligence
Proper due diligence ensures the benefits of the business structure will be upheld if challenged from a legal or tax standpoint.

Electing to be taxed under a corporate structure requires certain formalities. As the old adage goes, if you are going to 
call it a duck, it had better, look, walk, and quack like a duck. The same goes for your business. Organizing and 
maintaining your business under a corporate structure requires the owners to exercise proper due diligence in order to 
ensure that the benefits of the structure will be realized and upheld if challenged from a legal or tax standpoint. In 
addition to filing the proper corporate documents at the onset to establish a legal structure, there are several ongoing 
responsibilities that must be done on a recurring basis. 

This download summarizes some of the important areas where 
corporate due diligence must be maintained. In particular, this discussion focuses on S Corporations, although some 
of the items are also relevant to C Corporations and Partnerships.

Contact: Randy Juedes, CPA
Cool Down With a Dip Into Your Tax Records
In many parts of the country, the dog days of summer are a good time to stay inside. If you're looking for a practical activity while you beat the heat, consider organizing your tax records. Granted, it may not be as exhilarating as jumping off the high dive, but a dip into these important documents now may save you a multitude of headaches later.  

Tax Law Rules
Generally, you should keep tax-related records as long as the IRS has the ability to audit your return or assess additional taxes - in other words, until the statute of limitations expires. That means three years after you file your return or, if later, three years after the tax return's original due date.

In some cases, the statute of limitations extends beyond three years. If you understate your adjusted gross income by more than 25%, for example, the period jumps to six years. And there's no statute of limitations if you fail to file a tax return or file a fraudulent one.

Longer Periods
Although the IRS statute of limitations is a good rule of thumb, there are exceptions to consider. For example, it's wise to keep your tax returns themselves indefinitely because you never know when you'll need a copy of your individual income tax return.
For one thing, the IRS often destroys original returns after four or five years. So if the IRS comes back 10 years later and claims you never filed a return for a particular year, it can assess tax for that year even though the limitations period for properly filed returns has long since expired. As you can see, it would be difficult to defend yourself without a copy of your tax return.

W-2 forms also are important to keep at least until you start receiving Social Security benefits. You may need them if there's a question about your work record or earnings in a particular year.

Property and Investments
If you have property records, it's ideal to keep closing documents and records related to initial purchases and capital improvements until at least three years (preferably six years in case you understated your income by more than 25%) after you file your return for the year in which you sell the property.

When it comes to sales of stocks or other securities, retain purchase statements and trade confirmations until at least three years (preferably six years) after you file your return for the year in which you sell these stocks or other securities.

Grains of Sand
Many years' worth of tax and financial records can accumulate like grains of sand on your favorite beach. So the better your documentation is organized, the easier time you'll have filing your return every year and dealing with any IRS surprises. Our firm can assist you in determining what you should keep. 

Contact: Debbie Denny, Advanced Certified QuickBooks ProAdvisor